Tuesday, November 3, 2015

The Economics of Squirrels! or What is GDP and how does it grow?

The economic world of squirrels
After reading my last post on minimum wage policy, a friend of mine asked: “does increasing the minimum wage actually increase the overall supply of goods, or does it simply redistribute that existing fixed quantity?” This is a very cool question, and to answer it, we first have to understand what makes up gross domestic product (GDP).
           
What is GDP?
GDP is the total amount of value produced by a country in a calendar year. It is the sum of what everyone spends, what everyone invests, what the government spends and what the country sends to and receives from other countries. The equation looks like this:

GDP =


So, let’s say that six squirrels live in the same tree and each squirrel can gather 100 nuts in a year. The government then taxes each squirrel 10 nuts, and spends those 60 nuts fixing up the tree. A squirrel-preneur, whom we will call Richard spends 50 of his nuts building a store to sell peanut butter, and Jim (the really excited guy on the right) exports 10 nuts to a neighboring tree and all other nuts are consumed. The GDP here is:

Consumer: Production: (100 x 6) – Taxes: (10 x 6) – Savings: (50 + 10) = 480
Government: 60
Investment: 50
Exports: 10
Imports: 0
GDP = 600.

What makes GDP grow?
Because GDP is the main measure of prosperity in our world, we are often obsessed with making it grow. So how could we increase the GDP of this tree?

The first way of increasing the output of the tree would be to add more squirrels. As population grows, so does GDP, because each additional squirrel can harvest 100 more nuts per year.
Squirrel Babies!
The second major influence on GDP is technology. If the squirrels are given reacher-grabbers, they can gather more nuts, increasing their production and the tree’s GDP.
The internet does not yet have a picture of squirrels using reacher-grabbers, 
it’s never let me down like this before. 
The last major influence is capital. This is the investment in factories, machines, buildings, etc. that can be used to produce additional goods. In this example, the peanut butter store built by Peter is an investment in capital. Technology and capital both add to GDP because they increase the productivity of workers, or replace workers and allow them to labour elsewhere without decreasing the tree’s productivity.


These three things: population growth, technology and capital are the only methods of increasing total economic output in the long run. If the population doesn’t grow, and investment and technology remains the same, GDP does not grow.

But GDP changes all the time!
Yes, GDP changes all the time for a variety of reasons: first, the human population continues to grow.


Second, technology is making us more productive:
This is okay, but my dream is to be an automatic teller.
Third, since 2006, Canada has invested an average of 23.5% of its GDP into fixed capital (stores, factories, oil rigs, etc.). This money continues to improve the efficiency of works and develop new products like the iPhone 6S.

Last, there are many methods of adjusting when certain transactions are realized. For example, if you raise interest rates, people are more likely to save their money, deferring the production and purchase of things like cars and houses. This means GDP this year will decrease, but the total economic output of the system is not necessarily impacted, as that money might be spent next year instead. This gets at the concept of long-run equilibrium, which you can read about here.

So back to the original question: would increasing minimum wage raise total economic output?
The answer is: not necessarily. This is because when you raise minimum wage, you are mostly diverting money that would have otherwise been saved or spent elsewhere into increased labour costs.  Thus, you are not changing the total economic value of the system, but just adjusting when that value is realized. 

For example, McDonald’s will be required to pay its employees more money, meaning they will charge more for cheeseburgers, so families dining there will have less disposable income to save or spend elsewhere. Therefore, money that would have been spent later (perhaps after retirement?) is being spent now on a more expensive Big Mac.

However, the additional money that is being earned by minimum wage employees is then spent, and spent again, and again (according to the multiplier effect – see my last blog post), which could produce more economic value this year than would have been created if that money had been saved or spent elsewhere. This additional economic value might then be invested (in technology or factories), or used to afford more children, increasing long-run economic output.

Thanks for reading
Let me know if you have any questions about minimum wage policy, or if you would like me to cover a particular economic topic in the future. For my next post, I am going to look at murder rates and gun policy.

Sunday, September 6, 2015

What happens when you raise minimum wage?

What happens when you raise minimum wage?
Since the NDP was elected in May, a fierce debate has raged in Alberta. On one side, proponents herald a “living wage” for all Albertans, and on the other, opponents predict economic destruction.

This post discusses who makes minimum wage, what has happened in the past when minimum wage was increased, and what could happen to Alberta when the minimum wage is raised over the next few years.

Who makes minimum wage in Alberta?
According to Labour Alberta, about 370,000 workers (or 22% of the working population) in Alberta make less than $15/hour. With 38,000 people making the current minimum wage of $10.20/hour ($9.20 if you’re serving alcohol).

Aren’t teenagers the only ones making minimum wage?
65% of minimum wage earners are over 20, and 50% are 25 and over.


Aren’t minimum wage jobs temporary?
67% of people in Alberta work a minimum wage job as permanent, year-round employment.

Economic theory: raising minimum wage
Economic theory separates minimum wage impacts into three key categories:

1) Increased inefficiency (or unemployment) in the labour market,



2) Increased spending (or economic output) by those now making a higher wage,

Jerry the Giraffe pays Terry the Turtle to repair his kitchen sink 
and then buys carrots off this very entrepreneurial rabbit.


3) Increased spending by those receiving the increased spending by those making a higher wage (what economists call the multiplier effect).
Terry the turtle goes drinking with a bear in lederhosen and then pays a monkey cab driver to drive him home (don't drink and drive), and that entrepreneurial rabbit pays a hamster to do his taxes, and a dog to build an extension to his home. 
So theory says it could go either way, but what actually happens when you raise the minimum wage?
The Canadian Centre for Policy Alternatives analyzed every instance of raising minimum wage in Canada between 1982 and 2012 (70 times in total), and tried to isolate the impact that the increase in wages had. They found the unclear impact that theory suggests. Out of 70 times minimum wage was increased, 63 instances (90%) saw no connection between the increase in wages and higher or lower employment. In the remaining 10% of the times, an increase in employment was found 3 times, and a decrease was found 4 times.

Given how unclear the impacts are, what should we do?
Stats Canada’s recent report on minimum wage shows that it has remained largely unchanged in real terms (adjusted for inflation) since the 1970s. This means that in an average Canadian city, people making minimum wage today have roughly the same buying power as people who were making the minimum wage in 1973. However, in the province of Alberta, prices have increased faster than any other province (since 2002, inflation has been 32.4%), meaning that buying power of those making minimum wage has decreased substantially. Minimum wage is one way of making sure that all Albertans can afford to live.

But isn’t this increase to minimum wage bigger than others and won’t that cause prices to go sky-high?
To see what a shift from the current minimum wage of $10.20 an hour to $15.00  an hour looks from a business perspective, let’s imagine a made-up burger restaurant that sells 4,000 burgers each month in 2015:

Costs
Dollars per burger  
Labour (4 employees at $10.20 per hour)
$1.64
Buns/meat, etc.
$2.50
Rent ($1800 per month/4000 burgers)
$0.45

So how would the increase in labour costs affect the cost of this burger?
If Inflation over the three years is 2% per year, and minimum wage rises to $13 in 2016 and $15 in 2018, we can see the following impacts:




Over the course of three years, the cost of a burger for this business rose by less than $1, and 20% of this increase was from inflation! This example is fairly simple, but it does show that the impact to costs are likely quite modest and as a result, could be passed to consumers without causing them to buy less of it.

What is the potential impact to Alberta’s economy?
So if 370,000 people currently make below $15/hour, what is the economic impact of raising their wages to $15/hour?

Well we know that 38,600 employees make the minimum wage and the average wage in Alberta for the food and accommodation sector is $12.76, so those making less than $15/hour combine to make about $6.9 billion per year (or $18,740 per person before taxes).

At $15/hour, their wages combine for a little over $8.3 billion (or $22,500 per person before taxes). This additional $1.4 billion then gets spent and spent in the economy (multiplier effect). If minimum wage earners save 20% of their wages and spend the rest, then the impact to the Albertan economy could be almost $7 billion per year, or an increase of about 2%.

Thanks for reading
Let me know if you have any questions about minimum wage policy, or if you would like me to cover a particular economic topic in the future.

Sources